The Australian : Yield too tempting!

Telstra yield too tempting after TPG Telecom hit


Telstra shares finally bounced back yesterday after a sell-off prompted by TPG Telecom’s decision to compete in the mobile-phone market.

Telstra

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• The Australian
• 12:00AM April 20, 2017
• DAVID ROGERS
• 
  Markets Editor
  Sydney
  @DavidRogersOZ
  

After a tumultuous three days, Telstra’s dividend yield finally became too tempting to resist.
Shares in Australia’s biggest telco surged 3.3 per cent to $4.13 yesterday, the most since 2011.

The bounce in Telstra came after it dived more than 12 per cent to a 4½-year low of $4 after TPG Telecom’s announcement last week that it was planning to build a rival mobile phone network.

A 7.5 per cent fall in Telstra last Wednesday marked its worst day since 2010 and its fourth-biggest fall since listing in 1997. Indeed, it was a vicious sell-off in the blue chip telco, particularly considering that it had already fallen more than 30 per cent from its 2015 peak of $6.74, and UBS analysts had flagged the entry of TPG as a fourth mobile network operator last month.

While some of the fall in Telstra may have been warranted by the competitive threat from TPG, that looks priced in now. The current share price is well below the average 12-month price target of analysts, which has been revised down from $4.83 to $4.63 since TPG’s announcement. Most have hold ratings on the stock, and the price fall prompted upgrades from JPMorgan and Deutsche Bank.

The sell-off in Telstra could have been magnified by investors raising cash to take up TPG’s $400 million share offering to help pay for the mobile network and spectrum purchase. Telstra has long been a popular “funding stock” for institutional investors and it was no surprise that the entire telco sector surged a day after the capital raising was completed.

At its low of $4 a share this week, the price-to-earnings ratio of Telstra — based on expected earnings for the year ahead — hit a four-year low of 11.7 times. That was almost 14 per cent below Telstra’s average PE valuation since 2005. It was also a 25 per cent discount to the current PE valuation of the S&P/ASX 200 share index versus a “normal” discount of less than 1 per cent.

Even allowing for the possibility of some reduction in earnings that could cause some fall in Telstra’s dividend, the current valuation discount to the market seems excessive. Interest rates around the world remain near record lows following years of cuts and quantitative easing from the major central banks.

After peaking at 2.64 per cent in December, the global benchmark US 10-year bond yield has fallen to a five-month low of 2.16 per cent as disappointing US economic data for March have dampened a June interest rate increase from the Fed, Donald Trump’s ability to enact healthcare reform has cast doubt on his ability to deliver fiscal stimulus and geopolitical jitters have fuelled haven buying.

But while other major yield stocks in the property, infrastructure and utilities sectors have surged since the US 10-year bond yield dived from over 2.6 per cent in mid-March, Telstra has slumped. For local shareholders — who can use the 100 per cent franking credit available on Telstra shares — the indicative “grossed up” dividend yield hit a five-year high of 11 per cent this week. Even for offshore investors, a net dividend yield of 7.4 per cent on Telstra will be attractive.

The best prospective dividend yield on Telstra in five years may reflect some risk of a dividend cut. UBS said last month that such a move would be “prudent” because of execution risk around its ability to fill a $2 billion-$3bn EBITDA gap, its desire to maintain an “A” band credit rating ahead of a sizeable upcoming refinancing task, looming capital requirements and the potential threat of a fourth mobile entrant — UBS certainly got that right.

But UBS’s long-term dividend forecast of 29c a share for Telstra is just 6.5 per cent below the current dividend and it expects Telstra to hold its dividend until June 2019. That implies investors could enjoy a couple of years of exceptionally strong dividend yields.
A potential dividend cut could tend to cap Telstra shares on rallies above the consensus target price, particularly while investors worry about a potential loss of market share to TPG. But as Deutsche Bank pointed out when it upgraded Telstra to a buy rating this week, TPG’s entry as a fourth mobile entrant could be mitigated by Telstra’s superior network, its incumbent position and loyal customers, the potential for Telstra to use a “fighter brand” to preserve core customer economics, and the lack of TPG stores to drive subscriber growth.